Monday, November 15, 2010

A recurring claim in doomer literature is that our economy must either grow or collapse. This claim is frequently made on peak oil and doomer websites, like theoildrum.com, energyresources.net, and elsewhere. It's also frequently re-iterated by adherents of the "ecological economics" school of thought such as George Mobus.

The growth-or-collapse claim has an argument which runs like this. In our economy, debt is extremely widespread. The government has debt, corporations have debt, and individuals have debt. But debt is nothing more than a requirement to pay more money in the future. The only way we'll be able to pay more money in the future, is if we have more money in the future, through economic growth. Without growth, we cannot possibly pay additional money in the future, because there will be no additional money in the future with which to pay. Therefore, an economy with widespread debt must either grow or collapse.

Or so goes the argument. This argument (which I've called the "growth-or-collapse" argument) is extremely widespread in doomer circles. It's rarely spelled out in any great detail. Usually, it's presented very briefly or just assumed. Nevertheless, it comes up very frequently in doomer literature.

Unfortunately, the growth-or-collapse argument is false. It relies upon two mistaken assumptions, outlined below.

First, the growth-or-collapse argument relies upon the implicit assumption that all our income is devoted to debt servicing. Only then would we require more money in the future to avert collapse. At present, however, we (including our government) devote only a small fraction of our income to debt servicing. As a result, we could continue to make debt payments despite no growth in income by sacrificing consumption spending. Let me give an example. Suppose someone (we'll call her Alice) makes $50,000 per year and takes out a loan of $5,000, payable in one year with 10% interest. In other words, she owes $500 more at the end of the year than the value of the loan she took out. As it turns out, Alice doesn't receive an expected pay raise. Nevetheless, she must pay back $500 more at the end of the year. Is she bankrupt? No, because she can pay her debt by sacrificing a small fraction of her consumption. Only about 1% of her income is devoted to paying interest, which is less than her discretionary spending, so she would not face bankruptcy even if she underwent a relatively severe contraction of her income.

What about people who are so heavily indebted that they cannot possibly pay their debts using their current income? What about people who bought million-dollar homes and could not afford any of the payments without an increase in their salaries? Only those people require income growth to avert bankruptcy. By the way, that situtation is not faced by our government or most of our corporations. At present, our government pays only a relatively small fraction of its income for debt servicing and therefore does not require any growth in revenues to avoid default; and the same goes for the vast majority of corporations and people.

But there are some people and corporations who require growth in their incomes to avert bankruptcy. Do they face collapse? Will they cause the collapse of the whole economy?

No. That's the second mistaken assumption of the growth-or-collapse argument: it conflates bankruptcy with collapse. Bankruptcy is nothing more than a transfer of ownership of assets from one entity to another, along with a legal debt cancellation. Nothing more. It does not imply collapse, not even for the entity declaring bankruptcy, much less for society more generally. For example, assume a manufacturing corporation which cannot pay its debts and which declares bankruptcy. It's assets are transferred from stockholders to banks and bondholders who now own the company, and its debts are cancelled. The bondholders will continue to run the company if it's profitable without the prior debts. The new owners have no more incentive to destroy its assets than the previous owners did. In other words, bankruptcy and debt have no effect whatsoever on whether factories will continue to run. Bankruptcy changes ownership, that's all. The only time a company is dissolved, and its factories closed, is when it's not needed anymore, because its products or factories are obsolete or there's a surplus of the products it supplies. For example, GM almost dissolved because of competition from many other automakers who provide the same kind of products, so GM is not necessary in the world at all, any more than AMC was in the 1980s. (Even if GM had been allowed to fail by the US government, it still wouldn't mean collapse in the doomer sense of that word, because its capital equipment (like factories and machine tools) would be sold to competitors who would increase their production. Again: bankruptcy is a transfer of ownership, even in the case of legal dissolution, which is rare. Bankruptcy is a paper procedure which has nothing to do with physical destruction or collapse).

In short. The growth-or-collapse argument is false. It relies upon two implicit assumptions, both of which are false. It would be refuted if either of its assumptions were false, but both of them are false.

The economy requires no growth to survive. It could continue along with 0% growth for decades or longer, despite loans at interest, without any risk of collapse. (In fact, that very situation is what happened almost everywhere for the vast majority of human history, without any society collapsing from debts). In fact, the economy could withstand declining income because debtors could continue to pay their debt by sacrificing other expenditures. Furthermore, those who are forced into bankruptcy cause nothing more than a paper transfer of ownership and legal procedures of debt cancellation. As a result, debt poses no risk of economic collapse and does not create a requirement for growth.

None of this concedes that economic growth is at an end. Economic growth has not ended, and is not ending anytime soon. But that's a topic for another article.